Essay about Fi516

817 Words Dec 26th, 2011 4 Pages
(TCO D) Which of the following statements is most CORRECT?

(a) If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
(b)The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.
(c)The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
(d) If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are
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Gross funds:
Gross funds: $5,000,000
Current price:$5.00
Small fee: 6%
Expected price:$6.50
Normal fee: 10%
Possible price:$12.00
Option shares: 200,000
Required return: 15%
Fee received now = 6% × $5,000,000 = $300,000
Additional fee: Option profit if the stock price is $12 in 1 year = ($12 - $5) x 200,000 = $1,400,000
PV of total compensation if $12 price = $300,000 + $1,400,000/(1.15)1 = $1,517,391

(TCO D) Oxford Corp. is considering refunding a $30,000,000, annual payment, 12 percent coupon, 30-year bond issue that was issued five years ago. It has been amortizing $2 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 10 percent in today's market. A call premium of 12 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $2 million. Oxford's marginal tax rate is 30 percent. The new bonds would be issued when the old bonds are called.

What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

(a) 4,520,000
(b) 3,020,000
(c) 4,020,000
(d) 5,020,000
(e) 5,520,000

Answer is: c
Chapter 20, pp. 810 - 815
Years remaining on old bond: 25
Old issue flotation costs:
Remaining unexpensed = (25/30)($2) = $1,666,667
Tax saving on unexpensed float cost = $1,666,667 x 30% = -500,000
After tax

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